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Executives

Daniel T. Accordino - President and Chief Executive Officer

Paul R. Flanders - Vice President, Chief Financial Officer and Treasurer

Analysts

Bryan Hunt - Wells Fargo Securities

James Fronda - Sidoti & Co.

Carrols Restaurant Group, Inc. (TAST) Q3 2013 Earnings Conference Call November 5, 2013 8:30 PM ET

Operator

Ladies and gentlemen, welcome to the Carrols Restaurant Group Inc. Third Quarter 2013 Earnings Conference Call on the 5th of November, 2013. Throughout today's recorded presentation, all participants will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions. (Operator instructions) I will now hand the conference over to Paul Flanders. Please go ahead, sir.

Paul R. Flanders

Good morning. By now you should have access to our earnings announcement released earlier this morning which is available on our website at www.carrols.com under the Investor Relations section.

Before we begin our remarks, I would like to remind everyone that our discussion will include forward-looking statements which may consist of comments regarding our strategies, intentions, or plans. These statements are not guarantees of future performance and therefore undue reliance should not be placed on them. We also refer you to our filings with the SEC for more details, especially the risks that could impact our business and our results.

Please note that during today’s call we will discuss certain non-GAAP measures which we believe to be useful in evaluating our performance. A presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP. A reconciliation of comparable GAAP measures is available in our earnings release.

I will now turn the call over to the President and CEO of Carrols Restaurant Group, Dan Accordino.

Daniel T. Accordino

Thanks, Paul, and good morning, everyone. We consider our third quarter performance respectable in light of the general weakness in consumer spending during the period, heightened competition within QSR throughout the year, and a difficult prior year comparable sales comparison of 6.2%.

Third quarter comparable restaurant sales increased 0.4% on an overall basis including an increase of 0.6% at our legacy restaurants and a 0.2% increase at our restaurants acquired in May 2012. On a full year basis, comparable sales were up a solid 6.6%, reflecting the success of Burger King initiatives aimed at widening the overall appeal of the brand.

Burger King continues to focus on a balanced marketing approach, offering value oriented products at multiple price points to drive traffic while highlighting premium offerings on a limited time basis for both brand and check building. We believe that effective promotion of both value and premium products has been key to our maintaining positive sales momentum in the face of increased competition and economic pressures.

In terms of value, third quarter promotions included the 2 For 5 Mix and Match special, a newly introduced french fries burger and a $0.50 small ice cream cone among others. On the premium side, Burger King launched its new Buffalo Chicken Strips and featured a premium Chicken Parmesan Sandwich. We also saw the return of the Angry Whopper and an expanded summer barbecue menu which included a Memphis Pulled Pork BBQ Sandwich, the Carolina BBQ WHOPPER and chicken sandwiches, a new Rib Sandwich and a BBQ Chicken Salad.

In late September, Burger King launched its innovative new better-for-you french fries called Satisfries that contained 40% less fat and 30% fewer calories than McDonald's french fries while not compromising on taste. The media buzz around this product launch was robust and initial customer response has been positive. Our incidence of customers ordering french fries has also increased since the rollout.

In terms of our third quarter performance, we increased adjusted EBITDA by 10% despite a modest 0.7% decline in restaurant sales. I just pointed out that while comparable restaurant sales increased 0.4%, total sales were down slightly compared to last year due to our closing of eight restaurants over the past 12 months.

The improvement in adjusted EBITDA, which excludes certain integration costs related to the acquisition and EEOC litigation costs from last year, reflected an almost 20% improvement in restaurant level EBITDA due to increased profitability of the acquired restaurants. This was partially offset by increases in our G&A expense due to higher bonus expense this year and a reduction in payments from Fiesta Restaurant Group as they continue to transition certain support services following last year's stop.

Restaurant level EBITDA, which is adjusted EBITDA before G&A expense, increased from $12.7 million in the third quarter of last year to $18.6 million, and excluding last year's integration cost, increased $3 million or 19%. Restaurant level EBITDA at our legacy restaurants was essentially unchanged on a year-over-year basis and margins remained strong at 15.2%.

Restaurant level EBITDA at the acquired restaurants increased $6 million in total and by $3 million excluding the integration cost from last year. Restaurant level EBITDA margin at the acquired restaurants increased more than 800 basis points compared to the third quarter of last year, and after excluding the integration cost, increased by over 400 basis points. This reflects the operating improvements that we've made over the past year that we see in our P&L results, our operational improvements and our customer satisfaction scores. Sequentially, the margin gap to our legacy restaurants widened about 119 basis points from the second quarter. This primarily reflected to the negative leverage in our fixed cost due to the sequential decrease in sales from the second to third quarter.

While operations have improved, as I indicated in the last call, our sales performance at the acquired restaurants has been muted by the performance of certain markets where sales trends for the brand have been softer, namely Virginia. In the third quarter, comparable restaurant sales were down 5.1% in our 41 Virginia restaurants. Given their location, we believe that the Virginia sales decline was at least partially due to the impending U.S. government shutdown and the effects of those sequestered.

However, the performance in this market has been more than offset by positive sales trends in almost every other acquired market. Sales at the 112 North Carolina restaurants increased 2.4% for the quarter. We were also up 3.2% in Dayton, 4.3% in Philadelphia and 8.9% in Louisville, although our presence is smaller with only 10 to 15 restaurants in each of these markets.

Turning to our ongoing remodeling efforts, we considered the remodeling of 93 restaurants during the first nine months of the year, bringing the total number of units upgraded to the 20/20 design image to over 180. For the full year, we are on pace to remodel a total of 110 to 115 restaurants in 2013 and we'll conclude the year with approximately 35% of all our units remodelled to new image.

To conclude, I would characterize the third quarter as respectable under the circumstances. Comparable restaurant sales increased 0.4% marking the ninth consecutive quarter of positive growth. While sales gains were modest in the face of economic and consumer pressures, we were able to maintain margins at our legacy restaurants despite higher promotional activity this year. As I said, we have made considerable operational and P&L improvements for the acquired units over the past year. In October, sales trends reaccelerated and our comparable restaurant sales increased 3.3% for the month. We expect that sequentially sales trends will be better in the fourth quarter, as reflected in our updated guidance.

With that, I'll now turn the call back over to Paul to continue our financial review.

Paul R. Flanders

Thanks Dan. Restaurant sales decreased 0.7% to $168.3 million in the third quarter from $169.5 million last year. The higher comparable restaurant sales were offset by eight fewer restaurants in operation at the end of the third quarter of this year. Legacy restaurants generated $94.3 million in sales compared to $94.4 million last year and the acquired restaurants generated $74 million in sales compared to $75.1 million in the same period last year.

Comparable restaurant sales increased 0.4% on an overall basis compared to 6.2% in the year ago period, including an increase of 0.6% in legacy restaurants and a 0.2% increase in acquired restaurants. Average check was 0.1% lower due to the higher promotional activity and was more than offset by the increase in customer traffic of 0.5%.

Average weekly sales for the acquired restaurants were $21,008, and increased 1% from the third quarter of last year. This increase was net of an approximate 0.5% reduction from the elimination of 24 hour operations in many of the acquired restaurants during the second and third quarters last year.

Average sales of the acquired restaurants were 16.2% lower than our legacy restaurants. This difference widened sequentially due to seasonality differences between the acquired and legacy restaurants, namely differences between the Northern and Southern restaurants.

Adjusted EBITDA was $10.1 million in the third quarter compared to $9.2 million in the prior year and adjusted EBITDA margin was 6% in the quarter compared to 5.4% last year. As Dan said, the improvement in adjusted EBITDA reflected a 19% increase in adjusted restaurant level EBITDA at the acquired restaurants, partially offset by certain increases in our G&A expense.

Restaurant level EBITDA margins were 15.2% of legacy restaurants, essentially the same as the third quarter last year, on flat revenues. Cost of sales improved 35 basis points as favorable sales mix changes offset higher promotional discounting and modest commodity increase. However, restaurant labor costs increased 46 basis points in the quarter mainly due to higher unemployment tax rate and workers compensation costs.

Restaurant level EBITDA at the acquired restaurants, is adjusted to exclude $2.9 million of integration cost incurred last year, increased $3.1 million to $4.3 million. Adjusted restaurant level EBITDA margins were 5.8% and improved 422 basis points from the third quarter last year as we leveraged a number of expense items, most notably a 352 basis point reduction in cost of sales. You can find supplemental data and our restaurant level operating expenses in today's earnings release.

General and administrative expenses were $8.7 million or 5.2% of sales in the third quarter and decreased $0.6 million compared to third quarter last year. G&A cost in the third quarter last year included $1.9 million of expenses related to our litigation with the EEOC that we settled earlier this year and $0.5 million in integration cost related to the acquisition.

Depreciation and amortization expense increased from $7.7 million in the third quarter last year to $8.5 million this year due primarily to remodeling initiatives over the past year. Interest expense was $4.7 million in the third quarter compared to $4.5 million last year.

The net loss from continuing operations was $2.8 million or $0.12 per diluted share, including impairment charges of $1.1 million or $0.03 per diluted share after tax. This compares to a net loss from continuing operations of $6.3 million in the prior year or $0.28 per diluted share, which included integration costs related to the acquisition and EEOC litigation cost of $5.3 million in total or $0.14 per share after tax.

At the end of the quarter, our cash balances were $33.3 million including $20 million of restricted cash held as collateral for our revolving credit facility. Total outstanding debt was $160.7 million at quarter end, essentially unchanged from last quarter.

Capital expenditures for the third quarter of 2013 totaled $13.1 million including $9.4 million for restaurant remodeling. Total capital expenditures for the nine months were $40.4 million, 22 remodels were completed in the quarter and 93 restaurants have been remodelled so far this year.

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Finally, we are updating our guidance for 2013. In view of our results year-to-date, we are making some slight adjustments to our restaurant sales expectations. Total restaurant sales and now expected to be in the $660 million to $665 million range compared to $660 million to $680 million previously. Overall, comparable restaurant sales are anticipated to be between 2% and 2.5% in the fourth quarter.

Commodity costs are still expected to increase 1% to 2% for the year. G&A is expected to be approximately $36 million excluding stock compensation costs, and we plan to close approximately 10 restaurants this year, of which we have already closed eight. Our annual effective income tax rate is estimated to be between 42% and 45%, including the carryover benefit of the 2012 WOTC credits that were mostly recognized in the first quarter.

And lastly, capital expenditures are projected to add $50 million to $52 million for 2013 versus $40 million to $50 million previously, and includes $40 million to $42 million in remodeling a total of 110 to 115 restaurants. Our estimated remodeling expenditures include $6.5 million for the relocation of two restaurants to new sites and for cost to scrape and rebuild four restaurants. Excluding the two new restaurants and the relocations, the remodels are generally still expected to average about $300,000 for the year.

That concludes our prepared remarks, and with that, we'll now open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from Bryan Hunt from Wells Fargo Securities. Please state your question.

Bryan Hunt - Wells Fargo Securities

I was wondering if someone could comment on the same-store sales acceleration in Q4, do you think it's more of a reflection of general consumer sentiment or reactions to marketing and product changes, especially like the Satisfries?

Daniel T. Accordino

This is Dan. I would say, Bryan, that it certainly is more in terms of the marketing calendar. Satisfries certainly has added a certain excitement around the brand. [We sell only about] (ph) 52 Satisfries a day, and more importantly, it has increased our overall fry incidence by 25 a day. So it’s been somewhat incremental.

Furthermore, I think that the Burger King recalibrating the marketing calendar to be more value-oriented, this 2 For 5 promotion is working very well and Burger King is using the 2 For 5 platform to introduce or change out various products, which has been very successful and we saw that in September and certainly this is a trend that's carried into October.

Bryan Hunt - Wells Fargo Securities

The next question about sales, I mean when you look in October as well as – [is there anything] (ph) you can tell us about Virginia in particular? I mean you called it out in terms of being really negative for Q3, how about Q4, is it – has the tempo of same-store sales there changed?

Daniel T. Accordino

I think that they are seeing a bit of a rebound, similar to what we are seeing across the balance of the markets, but they are certainly still the softest market that we have. The North Neck has got 17 restaurants. One of those restaurants was down 30 plus percent in the third quarter and it's still continuing in the fourth quarter because there is no road in front of the restaurant which is [indiscernible]. That store in and of itself has over 1 percentage share point effect on the entire North Neck market.

We're in the process of now remodeling some of those restaurants and I think that we're going to start seeing a little bit of traction, but I met with Burger King last week and we are certainly going to with them because it's not just a Carrols phenomena, it's the whole entire DMA [indiscernible] purpose on it in terms of how we are going to market that – the Virginia market in 2014.

Bryan Hunt - Wells Fargo Securities

Okay, and then two more questions and one is a housekeeping. There's been a lot of talk at least in BKC worldwide about the performance of remodelled stores. As I think about your remodeled stores, the number you already completed, 110 to 115 this year and a 10% sales lift, I mean in round figures that should contribute – and looking what you did as well in 2012, in round figures it should contribute call it $8 million to $10 million to sales growth next year. Does that map work in your mind or does that make sense?

Paul R. Flanders

Yes, your numbers are close. We have seen about 10% lift in the first year and I think we are expecting a couple, 3%, in the subsequent year as well. And obviously we have a lot of good positive momentum in those stores that have been remodeled.

Bryan Hunt - Wells Fargo Securities

Okay, and then my last question, and again housekeeping, could you tell me the number of legacy versus acquired stores that are in the portfolio?

Paul R. Flanders

Yes, I think at the end of the third quarter, there were 291 legacy restaurants, 273 acquired restaurants.

Bryan Hunt - Wells Fargo Securities

Thank you very much. I'll get back in the queue.

Operator

The next question comes from James Fronda from Sidoti & Co. Please state your question.

James Fronda - Sidoti & Co.

Can you just talk about I guess anticipated store closures for 2014?

Daniel T. Accordino

I think in general relative to 2014, we are going to provide more guidance obviously on the next call. We are doing the process of putting our plans and so forth together now but our expectation is probably we're going to have probably 15 to 20 stores that he will close next year.

James Fronda - Sidoti & Co.

Okay, and I guess is there any way you can give a forecasted CapEx for 2014 or is it still the same?

Daniel T. Accordino

Too early.

James Fronda - Sidoti & Co.

Okay, alright. Thanks guys.

Operator

(Operator Instructions) We have a follow-up question from Bryan Hunt from Wells Fargo Securities. Please state your question.

Bryan Hunt - Wells Fargo Securities

Are the 15 to 20 stores that are to be closed in 2014, are those EBITDA negative stores, or would it be safe to assume that?

Daniel T. Accordino

[Maybe, that's there.] (ph)

Bryan Hunt - Wells Fargo Securities

Is there any way you could quantify the magnitude of losses of those stores?

Daniel T. Accordino

Not today. We will give some guidance on that in the next call. Primarily, Bryan, the restaurants are being closed in 2014. When we negotiated this deal with Burger King, they were stores that we had identified that were either slightly EBITDA positive or slightly EBITDA negative, and we agreed at the time that we did the transaction to keep those restaurants open for two years to see if we could make a difference. So those are really the restaurants we are talking about.

Bryan Hunt - Wells Fargo Securities

Okay, very good. Next, I mean Burger King has mentioned that there are two more focused product launches in Q4 in the portfolio. Is there any way you can give us kind of a preview on how those products may compare to Satisfries in terms of the marketing push and the relative price point?

Daniel T. Accordino

I think that the best way to answer that is that the products that are being viewed in the fourth quarter, one will be a modification to the value menu and the other will be introduced as part of the 2 For 5 promotion.

Bryan Hunt - Wells Fargo Securities

Alright, very good. And then lastly, I mean, Paul, if you look at kind of the outlook for next year and the anticipated CapEx, would you expect to be in a position to burn cash again in 2014?

Paul R. Flanders

As I said, we're putting our plans together now and let's see how the fourth quarter shapes up and how the economy improves here to get a sense of what – before we get a good sense of what 2014 looks like. Having said that, I think our intention would be to continue to do the remodels obviously. We probably are going to burn some cash doing that, and I think our sense is probably until we see how 2014 is shaping up, we might slow the pace down a little bit as we go in the beginning of the year.

Bryan Hunt - Wells Fargo Securities

Very good, I appreciate your time. Thank you.

Operator

There appears to be no further questions. Please continue with any points you wish to raise.

Daniel T. Accordino

We don’t really have anything else to add. We appreciate everybody joining us today and look forward to talking to you after the fourth quarter. Thank you.

Operator

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.

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